A chill has fallen over U.S./Russia relations in recent weeks; a chill noticed around the world. As the South China Morning Post has put it, Putin has discovered he can score political points at home “with his apparent tough stance with an old adversary.” By the time Edward Snowden was living in the Moscow airport like a Tom Hanks character, the White House decided that it had to show its own toughness, and it cancelled a bilateral summit that had been planned to coincide with the G20 Sherpas’ meeting in St Petersburg in September. That’ll show those Russkies!
At the same time, though, the White House made it very clear that the U.S. will still participate in the St Petersburg G20 talks themselves, September 5-6. Meanwhile, when I (speaking just for myself now) look at the Big Picture in the world today, I see the final unraveling of the non-systemic monetary system with which the world has coped, unsteadily, ever since Nixon closed the U.S. gold window.
Every currency in principle floats against every other, and since gold is regarded as just a useful raw material for jewelry, there is no underlying asset. Yet every nation and its central bankers have figured out that there are advantages to having your currency be cheaper than the other guys’: and since it is logically impossible for all currencies to be cheaper than the others, there is an awakening understanding that this can’t go on. The post-war relations among China, the U.S., and Russia all have to be defined in the context of this logical/monetary quandary.
To learn more about the interaction of central bankers, shiny metal, and world markets, I spoke recently to James G. Rickards, the author of Currency Wars, and a senior managing director of Tangent Capital in New York. Rickards has been intimately involved in financial markets for decades. Among much else, he was general counsel for Long-Term Capital Management and, in September 1998, principal negotiator of the deal sponsored by the Federal Reserve Bank of New York for LTCM’s orderly dissolution. I started with a question about gold. Its price had fallen off a cliff in April, going from 1550 to below 1400 in a heartbeat. Then it seemed to stabilize, only to have another sharp fall in June, taking it almost to 1200. Since then there has been some rebound, and it was at 1340 when we spoke. So I asked in general terms: why?
James Rickards: The first thing that anyone needs to know about gold is that it is volatile. The second is that in a dollar/gold trade, this is the dollar’s volatility. They are two sides of the same trade. The problem this spring and summer has been that nobody can figure out the value of a dollar, and the reason for that is the debate inside the Federal Reserve about tapering. My view is that the Fed will not start the tapering off of its QE policy in September. If I’m right and they don’t taper [that is, they announce a continuance of the aggressive bond buying], then watch for the dollar to weaken and gold to get stronger. If they do start to taper, watch for the reverse.
AllAboutAlpha: I’ve been reading a good deal of late about a country’s gold-to-GDP ratio. Is that an important statistic?
Rickards: It is important if, with me, you expect that the world will in time have to adopt some sort of gold standard. The phrase ‘the gold standard’ is misleading, there are many different ways in which one can structure a gold standard, or simply use gold as a reference of value, as suggested for example by Robert Zoellick in 2010. But given any resumption of a gold-based system, the most powerful countries will be the countries that have the gold. What is the best way to consider gold as a measure of relative economic power? One approach sometimes used is a measurement of the percentage of a nation’s reserves that is held in gold. The U.S. is in good shape, then, because it has 70% of its reserves in gold, whereas China has only 1% of its reserves in gold. But that, I submit, is a misleading measure. We don’t need a foreign currency, because we print dollars. So at least as long as the dollar retains its central measuring role in international transactions it isn’t surprising the U.S. doesn’t hold in reserve a lot of euros or pounds. We hold gold and we can produce dollars at will so we don’t really need foreign currency reserves. If you want to measure gold as a potential future backing for the economy, though, you need something more germane, and for this purpose one might consider the gold-to-GDP ratio. The ratio for the U.S. is now approximately 3%. For China, it’s at 0.7%. But that raises the issue of whether the Chinese are lying about their reserves. And clearly they are.
AAA: Where is Russia in terms of gold-to-GDP?
Rickards: Russia now, after an aggressive pattern of buying gold in recent years, has acquired 1/8th of the gold of the U.S. Russia has 1/8th the economy of the U.S., too, so in terms of the gold-to-GDP ratio they have attained parity. They’ve been very transparent about their buying, in contrast to the Chinese. Putin has also, not coincidentally, been very clear that he doesn’t want the U.S. dollar to continue to hold a central position in world markets.
AAA: Is this the real reason for the recent racketing up of Russia-U.S. tensions?
Rickards: There are lots of reasons for these tensions: Snowden, Syria, natural gas, and so forth. But gold and currency issues are surely part of that mix.
AAA: Finally, should investors care about the choice the White House appears ready to make between two candidates for the next Federal Reserve chair, now that it has become narrowed down (if reports are accurate) to either Janet Yellen or Lawrence Summers?
Rickards: Yes. There’s a difference. Yellen is a known quantity, a monetary dove who would be very slow to taper if at all, she might even speed the money creation. Summers is neither a hawk nor a dove. He’s a wild card, an unknown who might have the Fed engage in its money creation by buying assets other than Treasuries. He might buy stocks, for example, or munis.
AAA: So one possible scenario is that a Detroit bankruptcy causes the muni market to seize up, and the Federal Reserve decides to resolve this by becoming the muni-buyer of last resort?
Rickards: If you bring Summers in you run the risk he’ll think that’s a good idea.